WEBVTT - Can You Ever Actually De-Risk The Banking System? 0:00:02.640 --> 0:00:17.000 Bloomberg Audio Studios, Podcasts, Radio News. 0:00:19.160 --> 0:00:22.400 Hello and welcome to another episode of the Odd Lots podcast. 0:00:22.440 --> 0:00:24.800 I'm Joe Wisenthal and I'm Tracy Allaway. 0:00:25.280 --> 0:00:27.880 Tracy, you know, we do all these episodes about private 0:00:27.920 --> 0:00:31.760 credit and obviously hedge funds, multi strategy hedge funds in 0:00:31.800 --> 0:00:34.640 particular lately, and of course it all sort of seems 0:00:34.680 --> 0:00:36.920 to be part of a bigger story of a bunch 0:00:36.920 --> 0:00:39.200 of things that used to happen inside banks no longer 0:00:39.240 --> 0:00:40.440 happening inside banks. 0:00:40.320 --> 0:00:43.760 Right, And this has been like a continual process ever 0:00:43.840 --> 0:00:46.280 since like the two thousand and eight financial crisis, but 0:00:46.440 --> 0:00:51.479 even before that we had like big periods of bank disintermediation, 0:00:51.600 --> 0:00:54.320 which we talked about recently on that episode with Hugh 0:00:54.400 --> 0:00:55.640 van steinas. 0:00:55.520 --> 0:00:57.960 Totally, there's a lot going on and not all of 0:00:57.960 --> 0:01:01.160 these trends date back to the final victual crisis, but 0:01:01.320 --> 0:01:04.320 you know, this was obviously kind of an express goal. 0:01:04.480 --> 0:01:08.080 I think of the Dobb Frank regulations and just from 0:01:08.160 --> 0:01:10.640 my seed sitting here, like, yeah, it seems pretty good. 0:01:10.760 --> 0:01:14.160 Bunch of risky stuff like multi strategy hedge funds, et cetera, 0:01:14.480 --> 0:01:16.440 seems kind of risky. You can lose a lot of money. 0:01:16.440 --> 0:01:20.040 In theory, lending to random middle market companies seems like 0:01:20.080 --> 0:01:21.720 you could lose a lot of money. It's like, yeah, 0:01:21.720 --> 0:01:24.120 it seems pretty good that it's not happening inside the banks, 0:01:24.160 --> 0:01:26.959 and maybe that's good that it's not connected directly to 0:01:27.040 --> 0:01:28.480 deposit taking institutions. 0:01:28.680 --> 0:01:31.600 Yeah, And I think given the increases we've seen in 0:01:31.720 --> 0:01:33.880 rates over the past couple of years, the fact that 0:01:33.959 --> 0:01:37.679 like nothing really broke or exploded in the private credit 0:01:37.760 --> 0:01:41.480 market seems like a good sign. But again, it's still 0:01:41.520 --> 0:01:45.360 relatively small and it is growing very rapidly, so I 0:01:45.360 --> 0:01:48.280 think there are more questions to be asking about this 0:01:48.320 --> 0:01:49.200 particular space. 0:01:49.360 --> 0:01:53.280 Well, you brought up something recently on an episode of 0:01:53.400 --> 0:01:57.280 Synthetic Risk Transfers where banks sort of offload some of 0:01:57.320 --> 0:02:00.320 their credit risk onto third party entities, And that's really 0:02:00.320 --> 0:02:02.840 stuck in my head, which is, you know, Okay, so 0:02:02.920 --> 0:02:05.960 these third party entities take the risk of the assets 0:02:05.960 --> 0:02:08.600 from the banks, but then that's an asset that can 0:02:08.639 --> 0:02:11.600 be levered up. And where do you get leveraged, presumably 0:02:11.639 --> 0:02:13.600 from a bank, And so I have this like. 0:02:13.520 --> 0:02:15.320 Sort of very circular, isn't it. 0:02:15.440 --> 0:02:17.600 Yeah, And I just have this nagging thing in my 0:02:17.720 --> 0:02:19.880 head somewhere it's like, okay, yeah, great, we moved it 0:02:19.880 --> 0:02:22.400 all off the banks. There's okay, we're not going to 0:02:22.480 --> 0:02:25.560 have another two thousand and eight. But what if the way, 0:02:25.680 --> 0:02:27.960 what if in some way it still goes back to 0:02:28.000 --> 0:02:30.760 the banks. Yea, and the risk still is there and 0:02:30.800 --> 0:02:32.800 it just sort of takes the loop out and then comes. 0:02:32.840 --> 0:02:35.640 It goes into prime brokerage instead of the balance sheet. 0:02:35.800 --> 0:02:37.800 That's a good way to put it. And so like 0:02:37.840 --> 0:02:40.040 I'm still like, I'm like, eh, things pretty good, but 0:02:40.120 --> 0:02:43.200 maybe maybe there are still some reasons to be concerned. 0:02:43.440 --> 0:02:45.640 Can you ever? I guess maybe we could title this 0:02:45.680 --> 0:02:48.720 episode like, can you ever really de risk the banking system? 0:02:48.840 --> 0:02:49.080 Oh? 0:02:49.160 --> 0:02:50.520 That's a good one, let's use that. 0:02:50.919 --> 0:02:53.760 Okay, Well, I am really excited. We have the perfect 0:02:53.760 --> 0:02:56.240 guest on today's show, someone we've had on the podcast 0:02:56.280 --> 0:02:58.200 before and someone we've known and talked to for a 0:02:58.200 --> 0:03:00.760 long time. We're going to be speaking with Stephen Kelly, 0:03:00.880 --> 0:03:05.360 Associate director of Research at the Yale Program on Financial Stability. So, Steven, 0:03:05.480 --> 0:03:08.520 thank you so much for coming back on a lots. 0:03:08.000 --> 0:03:08.760 Great to be back. 0:03:08.919 --> 0:03:12.080 You know, sometimes you guys say literally the perfect guest, 0:03:12.120 --> 0:03:13.720 and so I'm old for too on that I've only 0:03:13.760 --> 0:03:14.680 gotten perfect guests. 0:03:14.680 --> 0:03:17.600 But well, you coming, we have people who complain about 0:03:17.720 --> 0:03:20.079 when we forget to say the perfect guest, but you've 0:03:20.120 --> 0:03:22.919 kicked it up to another level and are complaining about 0:03:23.000 --> 0:03:26.240 not saying, oh, literally the perfect guest. This is a 0:03:26.280 --> 0:03:26.679 new era. 0:03:28.040 --> 0:03:30.480 I do not think that the word perfect does not 0:03:30.720 --> 0:03:34.040 actually need any adjectives, right, because either it's perfect or 0:03:34.080 --> 0:03:36.040 it's not. It's sort of like the word when people 0:03:36.040 --> 0:03:38.840 that call something very unique. It's like either it's unique, 0:03:38.880 --> 0:03:40.720 one of a kinder, it's not. So I wouldn't take 0:03:40.720 --> 0:03:42.720 that too uh, I would agree with you. I wouldn't 0:03:42.720 --> 0:03:43.400 take that too literally. 0:03:43.400 --> 0:03:47.160 I would agree with you if you followed your own Okay, okay, 0:03:47.320 --> 0:03:47.920 that's fair enough. 0:03:48.000 --> 0:03:52.560 Stephen Kelly, literally the perfect guest made that correction. I 0:03:52.800 --> 0:03:56.560 just should I be like I said, Oh, everything seems fine. 0:03:56.600 --> 0:03:59.080 But are the reasons to think and we're going to 0:03:59.160 --> 0:04:02.200 get into specific so this is an incredibly broad question, 0:04:02.960 --> 0:04:05.839 but just conceptually, are there reasons to think about how 0:04:05.920 --> 0:04:09.520 these risks that migrate off of bank balance sheets find 0:04:09.600 --> 0:04:11.240 a way to migrate back onto them. 0:04:11.600 --> 0:04:13.640 It's totally valid. I mean, this is part of the 0:04:13.680 --> 0:04:15.640 story of two thousand and eight right as there was 0:04:15.680 --> 0:04:19.000 this whole shadow banking sector and it looked like risk 0:04:19.080 --> 0:04:22.560 had moved, and really it hadn't. The banks brought everything back, 0:04:22.600 --> 0:04:26.760 first voluntarily and then involuntarily. So you're asking the exact 0:04:26.800 --> 0:04:30.440 right questions. The IMF is now asking these questions and 0:04:30.600 --> 0:04:32.240 citing odd lots. I don't know if you saw the 0:04:32.279 --> 0:04:37.279 recent Global financi Stability report citing Tracy on exactly this issue. 0:04:37.760 --> 0:04:40.040 You talked about the synthetic risk transfers in your intro 0:04:40.920 --> 0:04:43.200 and this idea of like, okay, but are the banks 0:04:43.240 --> 0:04:45.760 really funding it? I would say, you know, to the 0:04:45.880 --> 0:04:49.440 extent we're running risk through another balance sheet. I mean, 0:04:49.560 --> 0:04:52.840 the banks really are more protected even if they are 0:04:52.960 --> 0:04:55.760 lending to a firm that's taking credit risk, because they 0:04:55.760 --> 0:04:58.320 do have that firm's capital and they have that firm's 0:04:58.560 --> 0:05:02.000 you know, alleged skill at managing these risks. And so 0:05:02.720 --> 0:05:05.039 part of the issue with all the financial crisis stuff 0:05:05.080 --> 0:05:06.800 was a lot of it was unfunded. We can get 0:05:06.800 --> 0:05:08.880 into synthetic risk transfers, and you had that great episode 0:05:08.880 --> 0:05:11.599 about how they're different and they're funded, but broadly, Joe, yes, 0:05:11.600 --> 0:05:12.240 you're asking. 0:05:12.040 --> 0:05:12.760 The right questions. 0:05:13.120 --> 0:05:15.880 Wait, okay, I have a very basic question, but what 0:05:16.080 --> 0:05:19.839 is actually happening in the financial system when someone puts 0:05:19.880 --> 0:05:23.599 money into private credit. So say I'm an investor and 0:05:23.680 --> 0:05:26.760 I'm going to invest I don't know, a million dollars 0:05:26.760 --> 0:05:31.000 in some private credit fund. What happens to that million dollars? 0:05:32.000 --> 0:05:35.200 Well, first, Tracy, you're probably taking the million dollars from 0:05:35.240 --> 0:05:40.320 an allocation towards junk bonds investment grade credit. So that's 0:05:40.320 --> 0:05:42.760 step one. I mean, the idea of like private credit 0:05:43.480 --> 0:05:46.400 is taking all these loans from banks or is eating 0:05:46.400 --> 0:05:48.520 the bank's lunch. We can put a pin in that 0:05:48.520 --> 0:05:50.480 for now, and we should come back to that. So 0:05:51.000 --> 0:05:54.520 usually that's what's happening, is this is an allocation away 0:05:54.560 --> 0:05:57.840 from whether it's other alternatives or other corporate credit. But 0:05:58.080 --> 0:06:01.400 the reality is this is deposits move around the banking system. 0:06:01.440 --> 0:06:04.480 There's no like people talk about private credit like its 0:06:04.480 --> 0:06:07.080 deposits leaving the banking system or it's you know, deposits 0:06:07.080 --> 0:06:10.400 are going to non banks. But there is no shadow 0:06:10.440 --> 0:06:13.560 bank without a bank. Apollo has bank accounts, Blackstone has 0:06:13.600 --> 0:06:16.440 bank accounts. When you transfer money into them, they put 0:06:16.480 --> 0:06:18.680 it in their account and then it's lent on to 0:06:18.839 --> 0:06:23.080 whomever is receiving the credit, and so you're changing the 0:06:23.160 --> 0:06:26.640 nature of the aggregate deposit franchise to the extent deposits 0:06:26.640 --> 0:06:30.000 are moving to a different kind of actor. But deposits 0:06:30.000 --> 0:06:31.360 can't leave the banking system. 0:06:31.760 --> 0:06:33.719 So we just take it a little step further. Just 0:06:33.720 --> 0:06:36.640 to be clear, Okay, I sell some junk bonds. I 0:06:36.720 --> 0:06:40.280 decided to allocate a million dollars to an Apollo private 0:06:40.320 --> 0:06:43.720 credit fund. They lend the money. Is Apollo further leveraging 0:06:44.200 --> 0:06:47.560 that lending up to juice returns or how leveraged are 0:06:47.600 --> 0:06:48.240 these funds? 0:06:48.400 --> 0:06:51.640 So what we're seeing is that they're increasingly so it's 0:06:51.680 --> 0:06:54.360 pretty scarce so far. And that was part of the pitch, right, 0:06:54.480 --> 0:06:57.520 is like Apollo came along in twenty twenty two when 0:06:57.520 --> 0:07:00.280 private credit was booming and said, hey, why mean you 0:07:00.279 --> 0:07:02.480 guys thought of this? We have like one times leverage, 0:07:02.480 --> 0:07:05.520 two times leverage. That's generally sort of the space that's in. 0:07:06.279 --> 0:07:08.719 But as we've sort of seen the market mature and 0:07:08.720 --> 0:07:11.720 the market grow, like, there's a good reason to lever 0:07:11.800 --> 0:07:14.920 these things up. If you're doing effectively bank credit, which 0:07:14.960 --> 0:07:18.080 sometimes they are, there's a reason banks are ten times 0:07:18.160 --> 0:07:20.800 levered like that that's the way the funding of the 0:07:20.840 --> 0:07:24.000 system works, and that provides a whole host of other 0:07:24.040 --> 0:07:26.960 benefits to the system. But there's also a cap on 0:07:27.000 --> 0:07:30.080 how much unlevered equity is out there. If you think 0:07:30.080 --> 0:07:33.880 about what the financial system exists to do, it's to 0:07:33.960 --> 0:07:37.520 create as many financial goods for us. What we need deposits, 0:07:38.040 --> 0:07:40.640 you know, other kinds of savings on as little equity 0:07:40.640 --> 0:07:42.960 as possible. Equity is the scarce resource and it's the 0:07:43.040 --> 0:07:47.360 input to the financial systems manufacturing process. And so you 0:07:47.520 --> 0:07:52.040 cannot recreate ten x, twelve x, fifteen x leverage from 0:07:52.080 --> 0:07:56.400 the banking system on one two x leverage in private credit. 0:07:56.520 --> 0:07:58.960 And that's the limit, you know, to your fear, Joe, 0:07:59.000 --> 0:08:02.559 that's the limit of how big this thing can grow. 0:08:02.920 --> 0:08:04.560 And we're sort of seeing that a little bit is 0:08:05.240 --> 0:08:07.600 the bigger private credit grows relative. 0:08:07.240 --> 0:08:08.000 To the economy. 0:08:08.840 --> 0:08:11.680 They're sort of nearing the kink on the funding curve 0:08:11.720 --> 0:08:14.080 as far as like what amount of funding is willing 0:08:14.120 --> 0:08:16.560 to be locked up as long term assets. Like the 0:08:16.600 --> 0:08:20.600 fundamental idea that like on demand par deposits can become 0:08:20.960 --> 0:08:23.880 locked up five year equity and a private credit fund 0:08:24.000 --> 0:08:24.560 is not real. 0:08:25.720 --> 0:08:28.320 Haven't we seen some private credit funds start to look 0:08:28.360 --> 0:08:32.000 at structures where investors can take their money out as well, 0:08:32.040 --> 0:08:34.680 like instead of having the five year lockup periods, people 0:08:34.720 --> 0:08:36.720 can go in and out as they need. 0:08:37.200 --> 0:08:40.320 Definitely, I mean, the long arc of financial history bends 0:08:40.320 --> 0:08:45.520 towards banks, and we've sort of seen private credit start 0:08:45.600 --> 0:08:47.680 to look more like banks. In One of the ways 0:08:47.760 --> 0:08:50.640 is these sort of interval funds or evergreen funds they're called. 0:08:51.000 --> 0:08:53.400 And basically these are just different types of structures that 0:08:53.480 --> 0:08:56.920 allow some amount of liquidity in the short term. And 0:08:57.360 --> 0:09:00.640 this is very very marginal steps. It's gated, it's limited, 0:09:00.679 --> 0:09:02.559 but you know it's gated after a certain percentage. It's 0:09:02.559 --> 0:09:05.200 limited by quarter, there's a certain time interval in which 0:09:05.200 --> 0:09:08.000 you can get it. It's not deposits yet, but that's 0:09:08.040 --> 0:09:10.319 one of the ways which funds have started to bend 0:09:10.360 --> 0:09:13.160 towards a banking model in addition to leverage. 0:09:13.840 --> 0:09:16.960 By the way, just speaking of the history of finance, 0:09:17.640 --> 0:09:20.520 is that entities try to make illiquid things a little 0:09:20.520 --> 0:09:23.559 bit more banked. Like there was a really interesting paper 0:09:23.600 --> 0:09:26.839 that came out recently from Tim Barker and Chris Hughes 0:09:26.880 --> 0:09:29.680 about the Penn Central bailout and in there, there was 0:09:29.720 --> 0:09:32.959 some talk about the history of CDs specifically and how 0:09:33.000 --> 0:09:35.240 there at one point there was this really hard lockup 0:09:35.240 --> 0:09:37.560 on them, but then entity has found ways to sort 0:09:37.600 --> 0:09:41.080 of you could liquidate and sell your right to that CD. 0:09:41.160 --> 0:09:43.920 So they always find a way to create liquidity out 0:09:43.960 --> 0:09:44.679 of illiquidity. 0:09:44.840 --> 0:09:47.560 Yeah, you can tronch anything with cash flows. To paraphrase 0:09:47.559 --> 0:09:49.800 reportentnerial on Meet the Parents, I mean, you can get 0:09:49.840 --> 0:09:50.600 anything out of that. 0:09:51.520 --> 0:09:54.600 Speaking of traanging, I wanted to ask one more basic question, 0:09:54.800 --> 0:09:58.680 which is this term retranching of risk in the financial 0:09:58.720 --> 0:10:01.199 system has come up a number of times. So Hugh 0:10:01.280 --> 0:10:04.120 Vansteinas used it in a recent episode. I'm pretty sure 0:10:04.280 --> 0:10:07.720 you've used it as well in your writing. Exactly what 0:10:08.000 --> 0:10:11.680 risk is being retranched here? Like, give us an idea 0:10:12.000 --> 0:10:14.640 of what types of things end up in private credit. 0:10:14.679 --> 0:10:16.640 I imagine a lot of it is sort of middle 0:10:16.640 --> 0:10:19.880 market stuff, stuff that, to your point earlier would have 0:10:19.880 --> 0:10:22.040 been in the junk bond market or the leverage loan 0:10:22.120 --> 0:10:24.240 market and is now going elsewhere. 0:10:24.720 --> 0:10:25.800 Yeah, that's exactly right. 0:10:25.880 --> 0:10:28.920 And so I mean I got this term from the GFC, 0:10:29.040 --> 0:10:32.320 the global financial crisis literature. I believe it originated with 0:10:32.360 --> 0:10:34.920 Gary Gordon Andrew metric and they used it to describe 0:10:35.400 --> 0:10:38.280 increasing haircuts in two thousand and eight. So the idea 0:10:38.320 --> 0:10:40.680 that you know, you have a triple A asset, you 0:10:40.720 --> 0:10:44.400 were haircutting at one percent, but now the market to 0:10:44.440 --> 0:10:47.920 resell that collateral is worse. You're more worried about your counterparty, 0:10:48.120 --> 0:10:50.280 and so you're going to haircut it thirty percent. You've 0:10:50.280 --> 0:10:53.040 sort of retransh what you've decided is triple A, and 0:10:53.120 --> 0:10:55.640 a lot of that was driven by market perception of 0:10:55.720 --> 0:10:58.840 risk as well as increased market demands from our capital. 0:10:59.040 --> 0:11:01.240 What we're seeing in the banking system is a little 0:11:01.240 --> 0:11:05.040 bit of market demands and a little bit of regulatory demand. 0:11:05.040 --> 0:11:08.480 So obviously BASL three, you know, is looming next to 0:11:08.520 --> 0:11:11.880 the maturity wall, and it's sort of saying banks may 0:11:11.920 --> 0:11:15.840 have to have more capital. The other thing is investors 0:11:15.880 --> 0:11:18.600 depositors are looking for a little more liquidity in banks 0:11:18.679 --> 0:11:23.360 than they were pre twenty twenty three. And frankly, interest 0:11:23.440 --> 0:11:27.160 rate risk at a certain point becomes credit risk, and 0:11:27.240 --> 0:11:31.120 so when rates go to five percent, banks aren't really 0:11:31.160 --> 0:11:33.760 like trying to be in the business of managing all 0:11:33.800 --> 0:11:36.280 the credit risk at five percent that they were avoiding 0:11:36.280 --> 0:11:39.000 at zero percent, and so getting out of that left 0:11:39.000 --> 0:11:42.480 tail and sort of retranching by selling things out of 0:11:42.480 --> 0:11:44.280 the banking system is sort of the aim. So it's 0:11:44.280 --> 0:11:46.760 all those three things at once, and it makes sense 0:11:46.800 --> 0:11:50.240 for banks to lean then on prime brokerage and lending 0:11:50.720 --> 0:11:52.040 the senior layers of these funds. 0:11:52.240 --> 0:11:54.480 Wait, this reminds me of something else I wanted to ask, 0:11:54.559 --> 0:11:58.439 which is I hear a lot about comparative advantages when 0:11:58.440 --> 0:12:01.240 it comes to private credit versus banks, in the sense 0:12:01.280 --> 0:12:04.920 that private credit might be better at managing certain loans 0:12:05.120 --> 0:12:08.400 to your point about higher interest rates? Is that true? 0:12:08.600 --> 0:12:12.240 And like, what if that comparative advantage actually look like 0:12:12.320 --> 0:12:14.600 Does it just mean the analysts that private credit firms 0:12:14.640 --> 0:12:17.280 are like pouring over the paperwork more than a bank. 0:12:17.320 --> 0:12:20.720 Can I think that's right? And I know Joe has 0:12:20.880 --> 0:12:24.839 rude the failure of the high touch banks in twenty 0:12:24.920 --> 0:12:27.560 twenty three. You know that banks that care about their 0:12:27.600 --> 0:12:30.920 customers are the ones that failed. But what that misses 0:12:31.040 --> 0:12:33.280 is that community banks didn't fail, and those do the 0:12:33.280 --> 0:12:35.600 same thing, and those don't have the attention of the market. 0:12:36.280 --> 0:12:38.120 And that's sort of kind of part of the pitch 0:12:38.120 --> 0:12:41.200 of private credit as well. Is like, you know, we're 0:12:41.200 --> 0:12:44.880 operating under less transparency. Again, we're seeing give on that 0:12:45.000 --> 0:12:47.800 as they've sort of been towards banks. But in theory, 0:12:47.840 --> 0:12:50.480 this is just a product and they do have some ability. 0:12:50.600 --> 0:12:53.920 It's a smaller group, sometimes as small as one to 0:12:54.000 --> 0:12:57.480 work with the lenders. We've seen lower default rates out 0:12:57.520 --> 0:13:00.840 of private credit versus their competitors and in leverage zones, 0:13:00.880 --> 0:13:04.800 but higher losses given to fault So you can multiply 0:13:04.840 --> 0:13:08.400 those two things together and come up with some lesser 0:13:08.480 --> 0:13:10.800 loss and in that case, you know, it makes sense 0:13:10.840 --> 0:13:12.160 to be allocated a private credit. 0:13:27.480 --> 0:13:30.280 You know, what I realized a little earlier in the 0:13:30.320 --> 0:13:35.200 conversation is that I actually don't know the difference in 0:13:35.600 --> 0:13:38.480 what the shadow banks the quote shadow banks were doing 0:13:38.559 --> 0:13:41.239 prior to two thousand and eight, and how their relationship 0:13:41.280 --> 0:13:44.679 with real banks was different than the current relationship. I mean, 0:13:44.720 --> 0:13:46.800 it's interesting because I remember, you know, one of the 0:13:46.840 --> 0:13:49.280 things that was going on, I think summer two thousand 0:13:49.280 --> 0:13:51.400 and seven or summer two thousand and eight, it was 0:13:51.440 --> 0:13:53.760 like a couple bear Sterns hedge funds, like just hedge 0:13:53.760 --> 0:13:56.920 funds that seemed like a really big deal, like seemed 0:13:56.920 --> 0:13:59.560 to be systemically important I think City had something maybe 0:13:59.600 --> 0:14:02.959 do what was the nature of those quote shadow banks 0:14:03.240 --> 0:14:06.480 and how they actually connected to the regulated banks. 0:14:06.880 --> 0:14:09.000 So the short version is that the nature of those 0:14:09.120 --> 0:14:12.880 is big banks with strong balance sheets like Bear Stearns 0:14:12.880 --> 0:14:15.560 and City put their name all over those shadow banks, 0:14:16.679 --> 0:14:20.480 but didn't actually have They weren't funding them themselves, they 0:14:20.520 --> 0:14:23.040 weren't actually on the balance sheet of the banks. So 0:14:23.080 --> 0:14:25.800 when pressure came in two thousand and seven and nobody 0:14:25.880 --> 0:14:27.680 knew this was going to be like a repeat of 0:14:27.680 --> 0:14:31.000 the Great Depression, City took all that stuff back on 0:14:31.040 --> 0:14:34.640 its balance sheet to protect its reputation. Bear took one 0:14:34.680 --> 0:14:37.640 of those hedge funds on back onto its balance sheet. 0:14:37.800 --> 0:14:39.960 These banks did not have to take on this risk. 0:14:40.000 --> 0:14:42.200 But they're going, Okay, we're going to stand behind our name. 0:14:42.240 --> 0:14:44.160 We're going to stand behind our clients who thought they 0:14:44.200 --> 0:14:46.280 were buying a Bear Stearns or a City Group product. 0:14:46.720 --> 0:14:48.800 And maybe that's a risk today. I don't know, you know, Yeah, 0:14:48.800 --> 0:14:49.480 well I was just going. 0:14:49.400 --> 0:14:51.240 To ask because you see these headlines right now now 0:14:51.320 --> 0:14:54.160 like JP Morgan is going to get into private credit 0:14:54.280 --> 0:14:56.080 and so forth, and so I get the idea that 0:14:56.120 --> 0:14:58.800 this is going to be be a separate funding vehicle 0:14:58.960 --> 0:15:01.640 be like off balance kind of sounds similar. 0:15:02.560 --> 0:15:04.600 Yeah, I think that's totally a risk. Is there a 0:15:04.640 --> 0:15:07.360 world where, you know, Citygroup has to bail out its 0:15:07.800 --> 0:15:11.520 Apollo partnership because they put Citygroup's name all over it? 0:15:11.600 --> 0:15:16.240 Maybe maybe Wait, that JP Morgan mentioned just reminded me 0:15:16.320 --> 0:15:19.400 of something. But a few years ago, well actually more 0:15:19.440 --> 0:15:21.680 than a few years ago, maybe in like twenty fourteen 0:15:21.840 --> 0:15:25.040 or something like that, I remember JP Morgan basically complaining 0:15:25.240 --> 0:15:29.040 that the prime brokerage business was a lot harder nowadays, 0:15:29.080 --> 0:15:32.080 and like the margins were slimmer and stuff like that. 0:15:32.520 --> 0:15:35.360 I think that's what they said. And yeah, fast forward 0:15:35.400 --> 0:15:38.240 to twenty twenty four and it seems like prime brokerage 0:15:38.360 --> 0:15:41.080 is a moneymaker for the big banks at least what 0:15:41.280 --> 0:15:41.920 happened there. 0:15:43.760 --> 0:15:45.600 So part of it might just be the growth of 0:15:45.960 --> 0:15:48.880 private credit. I mean, it has found a niche. I 0:15:48.880 --> 0:15:51.520 would think about it like a product, you know, Like 0:15:51.560 --> 0:15:53.960 I said, it's got this middle market like you alluded to, 0:15:54.240 --> 0:15:57.680 it's sort of got a different model and there's no 0:15:57.720 --> 0:16:01.960 reason that shouldn't exist along the spectrum of bank deposits 0:16:02.000 --> 0:16:06.080 to thirty year locked up funding to fund buried treasure 0:16:06.520 --> 0:16:10.360 expedition like it exists in that spectrum, which is kind 0:16:10.360 --> 0:16:12.560 of an academic answer, but it's true. I mean Mark Rohan, 0:16:12.960 --> 0:16:15.520 CEO of a POLLA recently had a comedy, said, you know, 0:16:15.560 --> 0:16:17.520 we'll get competed with like crazy, and then what's the 0:16:17.520 --> 0:16:20.320 difference between public and private? And I think that's right. 0:16:21.040 --> 0:16:23.400 It arose as a product in the years. I mean 0:16:23.400 --> 0:16:25.760 it doubled between twenty twenty and twenty twenty three. We 0:16:25.800 --> 0:16:28.480 can talk about why, but now they have banking needs. 0:16:28.560 --> 0:16:30.240 Like I said, there's no shadow bank without a bank, 0:16:30.280 --> 0:16:32.160 and they have banking needs and hedge funds too. 0:16:32.720 --> 0:16:35.160 So my takeaway so far from this conversation is that 0:16:35.200 --> 0:16:37.440 some of the questions were asked. Is not that there's 0:16:37.520 --> 0:16:39.920 like some big looming risk out there or like oh, 0:16:39.960 --> 0:16:43.160 this is a disaster waiting to happen. But mostly these 0:16:43.200 --> 0:16:46.640 are all like reasonable questions to be asking about where 0:16:46.680 --> 0:16:49.040 at some point risks could merge, or at least where 0:16:49.080 --> 0:16:52.640 regulators maybe want to think or try to get ahead 0:16:52.640 --> 0:16:56.760 of things. What tools or specific lines of inquiry have 0:16:56.840 --> 0:17:00.160 we seen from regulators or things regulators could do, or 0:17:00.200 --> 0:17:02.800 like we want to monitor this and I know that's 0:17:02.840 --> 0:17:05.120 already you've written about this, But what are the specific 0:17:05.160 --> 0:17:07.520 mechanisms and questions and things they could do. 0:17:07.840 --> 0:17:10.800 I mean, basically, so far, what we've seen is they've 0:17:10.840 --> 0:17:13.840 just been really annoying to banks. That's a cost, right. 0:17:13.880 --> 0:17:16.760 If you talk about why the economics of private credit 0:17:16.840 --> 0:17:19.720 makes sense, some of it is that, Okay, the market 0:17:19.760 --> 0:17:23.520 demands a lot less capital for certain risks than banking regulators, 0:17:24.000 --> 0:17:27.720 and there's some supervision attached to those capital regulations too, 0:17:28.200 --> 0:17:30.320 and so to the extent you're making supervision, you know, 0:17:30.440 --> 0:17:33.760 just more costly. It's annoying and banks say whatever, you know, 0:17:33.880 --> 0:17:37.639 like JPM Yeah, they're doing ten billion of private credit 0:17:37.680 --> 0:17:40.320 on balance sheet. That's like they just found that in 0:17:40.359 --> 0:17:42.280 the couch cushions and they're doing it. They put out 0:17:42.280 --> 0:17:45.280 a press release so they can serve their clients. And 0:17:45.800 --> 0:17:47.240 this goes back to kind of what we're talking about 0:17:47.240 --> 0:17:50.600 Elier about what the differences between banks and private credit. 0:17:50.800 --> 0:17:54.320 Banks being more about managing a deposit franchise, private credit 0:17:54.359 --> 0:17:57.240 being more the lending side. But really we've seen from 0:17:57.240 --> 0:17:59.879 the Bank of England, from the ECB, from the f 0:18:00.119 --> 0:18:03.080 say in Japan, from the FED, they're all starting to 0:18:03.119 --> 0:18:05.639 just probe banks about their exposure. They're lending to private 0:18:05.640 --> 0:18:09.280 credit funds and prime brokerage. Frankly, but that's step one. 0:18:09.680 --> 0:18:12.800 I mean, you hear regulators talk either one we need 0:18:12.800 --> 0:18:15.800 more authority to regulate the non banking sector like banks, 0:18:16.480 --> 0:18:19.600 or two. You know, the conservative side is, let's be 0:18:19.680 --> 0:18:21.600 nicer with Basel three, so you don't push all this 0:18:21.640 --> 0:18:25.320 stuff into private credit. The truth is always somewhere in 0:18:25.320 --> 0:18:28.639 the middle. Right now, supervisors have just become more annoyed. 0:18:30.000 --> 0:18:31.879 That's a good way of putting it. Wait, I have 0:18:31.880 --> 0:18:35.280 a bunch of questions. Okay, One, have you noticed any 0:18:35.440 --> 0:18:40.800 like substantial differences in supervisory approaches, Like is the BOE 0:18:40.920 --> 0:18:43.800 doing something different to the FED versus the BOJ I 0:18:43.840 --> 0:18:47.040 know you said they're all in info collection mode at 0:18:47.080 --> 0:18:49.960 the moment, but like there must be some differences. 0:18:50.680 --> 0:18:54.320 So generally this stuff goes better in foreign countries than 0:18:54.359 --> 0:18:56.560 it does in the US, particularly the Bank of England. 0:18:56.960 --> 0:18:59.800 They have like a system wide stress test now where 0:18:59.800 --> 0:19:03.879 they simulate shocks in theory through like the whole financial system. 0:19:04.359 --> 0:19:08.560 They're big on macro prudential stuff over there in the US, 0:19:09.320 --> 0:19:12.359 like the fact that the f SoC, the Financial Stability 0:19:12.400 --> 0:19:17.320 Oversight Council hasn't designated black Rock or its kin as 0:19:17.359 --> 0:19:21.840 systemically important under a Biden administration, It'll never happen. And 0:19:21.880 --> 0:19:24.040 I'm not saying they should have. I mean the idea 0:19:24.119 --> 0:19:26.080 is like they're not doing banking, they have no short 0:19:26.119 --> 0:19:27.160 term liabilities. 0:19:26.760 --> 0:19:28.040 Blah blah blah. 0:19:28.119 --> 0:19:30.320 But it just doesn't get that same reception abroad. So 0:19:30.359 --> 0:19:33.240 there's more, you know. I think it'll lean harder in 0:19:33.320 --> 0:19:36.399 Europe and elsewhere, but for right now, the US is 0:19:36.440 --> 0:19:38.640 just kind of like poking at it in the stress 0:19:38.680 --> 0:19:40.080 tests and in data collection. 0:19:40.600 --> 0:19:42.560 By the way, you mentioned that, like one of the 0:19:42.600 --> 0:19:46.200 binding constraints in the financial system is how much money 0:19:46.240 --> 0:19:49.160 is just willing to be locked away on a permanent basis. 0:19:49.400 --> 0:19:52.080 This is really, though, where the role of insurers comes in, 0:19:52.119 --> 0:19:55.480 because this is money that people put into a pod 0:19:55.560 --> 0:19:58.000 and they theoretically expect to get all of it back 0:19:58.040 --> 0:19:59.800 maybe at some point over the course of a lifetime, 0:19:59.800 --> 0:20:02.560